How Mauritius Tax Protocol Could Give India Powers To Probe Offshore Investments

Mauritius' decision to ratify the 2024 protocol amending its Double Taxation Avoidance Agreement (DTAA) with India could significantly strengthen India's ability to scrutinise offshore investment structures that are suspected of being created primarily to obtain tax benefits.

While the protocol has not yet entered into force, it introduces a key anti-abuse provision known as the Principal Purpose Test (PPT), allowing tax authorities to deny treaty benefits where tax avoidance is considered one of the main objectives of an arrangement.

The change could give Indian tax officials greater powers to directly question offshore entities claiming benefits under the India-Mauritius tax treaty, as per a report by The Economic Times (ET).

What Changes Under The Protocol?

The Mauritius Cabinet has ratified the 2024 protocol, which amends the India-Mauritius DTAA by incorporating OECD-backed anti-abuse provisions.

Under the proposed framework, treaty benefits may be denied if one of the principal purposes of an investment or corporate structure is to secure tax advantages under the treaty, as per ET.

At present, Indian tax authorities generally challenge treaty claims through the General Anti-Avoidance Rules (GAAR) or judicial anti-abuse principles.

Under GAAR, however, the final decision rests with a statutory panel, and authorities must establish that an investment structure is essentially a sham.

The PPT introduces a separate treaty-based test. It would allow tax officers to deny treaty benefits even where a Mauritius-based entity has operational substance, provided they conclude that obtaining tax benefits was one of the principal purposes behind the arrangement.

Mauritius continues to enjoy important treaty benefits, including grandfathering for capital gains on shares acquired before April 1, 2017, a lower 5% dividend tax and exemptions on certain equity derivative gains earned by foreign portfolio investors. However, the protocol will increase scrutiny of investment structures, as per ET.

What Is Principal Purpose Test?

The protocol aligns the India-Mauritius treaty with the OECD's Base Erosion and Profit Shifting (BEPS) framework by introducing a revised treaty preamble and the Principal Purpose Test.

A report by international financial and corporate services group Fidux said that the revised preamble explicitly states that the treaty aims not only to eliminate double taxation but also to prevent tax evasion, tax avoidance and treaty shopping.

The report added that the newly introduced Article 27B applies across the treaty and allows benefits to be denied if obtaining those benefits was a principal purpose of a transaction, unless the arrangement is consistent with the treaty's objectives.

Investors can still preserve treaty benefits by demonstrating genuine commercial substance, active business operations and legitimate economic reasons for their structures, as per Fidux.

Protocol Yet To Take Effect

Although Mauritius has approved ratification, the protocol has not yet become operational.

Both India and Mauritius must formally notify each other that they have completed their respective domestic legal procedures before the protocol enters into force.

The text of the ratified protocol has not yet been made publicly available, meaning further clarity is awaited on its precise scope, extent and date of application.

A report by EY said that Mauritius had initially delayed ratification after concerns were raised by investors.

It noted that the Mauritian Cabinet said Prime Minister Narendra Modi had assured Mauritius that India would not undermine the treaty benefits available under the DTAA, following which Indian authorities provided clarifications that were considered favourable by Mauritius.